Obviously Unexpected

“Markets are constantly in a state of uncertainty and flux and money is made by discounting the obvious and betting on the unexpected.”

-George Soros

Legendary global macro investor George Soros needs no introduction; nor does the aforementioned quote require any contextualization. So we will provide neither. It’s also Jobs Day so we don’t want to take up too much of your time with lengthy prose.

Back to the Global Macro Grind...

If nothing else, recent labor market strength is indicative of the #LateCycle nature of the current economic expansion insomuch as any trending deterioration from such strength would likely foreshadow the start of the next recession. Contrary to consensus across the investment community, there will be a next recession.

With respect to the “r” word, our analysis shows that a recession is not an imminent threat to the U.S. economy and the financial markets that underpin it. That said, however, the purpose of our macroeconomic analysis is to help investors “discount the obvious and bet on the unexpected”. In light of that, the following bullets contextualize the #LateCycle nature of the domestic labor market in order of leading to lagging:

Over the previous three economic cycles, the 3MMA of the YoY % Change in Nonfarm Payrolls peaked an average of 22 months prior to the onset of recession.

Over the previous three economic cycles, the 3MMA of Average Weekly Hours Worked peaked an average of 8 months prior to the onset of recession.

Over the previous three economic cycles, the 3MMA of MoM Nominal Change in Initial Jobless Claims troughed an average of 7 months prior to the onset of recession.

Over the previous three economic cycles, the 3MMA of the MoM Nominal Change in Nonfarm Payrolls peaked an average of 7 months prior to the onset of recession.

Over the previous three economic cycles, the 3MMA of the Unemployment Rate toughed an average of 6 months prior to the onset of recession.

Over the previous three economic cycles, the 3MMA of YoY % Change inWage Growth peaked an average of 1 month prior to the onset of recession.

Over the previous three economic cycles, the 3MMA of Total Employees on Nonfarm Payrolls peaked an average of 0 months prior to the onset of recession.

What this data should tell you is that if you’re anchoring on the trending deceleration in annualized employment growth, you’re likely way too early in expecting the economy to be in the latter innings of an economic expansion. Conversely, if you’re one of the many investors who are anticipating wage growth to accelerate fervently from here, you’ll likely be way too late in getting out of the way.

As such, the key indicators for investors to focus on with respect to the business cycle would be: average hours worked, initial jobless claims, sequential nonfarm payrolls growth, as well as the unemployment rate. Trends across each of these indicators prospectively signal the top in the economic cycle 2-3 quarters out, on average.

Of each of these, the indicator that is probably the most consistent is Initial Jobless Claims. Specifically, the rolling six-month average in this series has oscillated in a band of ~300k to ~600k over the previous three economic cycles. Even more consistent is its signaling capability as it relates to timing the onset of recession. Specifically, a recession has commenced 18 months, 19 months and 20 months after this indicator has breached 300k to the downside and/or toughed as it did at 305k in April of 2006.

For reference, June ’15 represented the eighth consecutive month the rolling six-month average of Initial Jobless Claims has been below the critical threshold of 300k. Additionally, the latest monthly average reading of 285k is the lowest since April of 2000 on a delta-adjusted basis (i.e. still trending down).

For the record, April of 2000 proved to be a difficult time for an equity investor to celebrate #LateCycle labor market strength as many are doing now, given that the stock market (S&P 500) was in the very early innings of a multi-year, (49.2%) correction.

Also for the record, April of 2006 proved to be a good time for an equity investor to celebrate #LateCycle labor market strength, given that the stock market (S&P 500) rallied +19.4% from 4/30/06 though its 10/9/07 all-time closing high.

All that being said, investors need to decide whether or not the current #LateCycle labor market strength is more indicative of April ’00 or April ’06 because the expected outcomes are extremely binary in financial market terms.

Going back to the aforementioned quote, if Soros’ investment framework is indeed appropriate, then investors need to “discount the obvious and bet on the unexpected” with respect to the labor, economic and financial market cycles.

This we know:

Per a recent Bloomberg article, sell-side strategists expect the S&P 500 to shake off its worst first half since 2010 and rise +8.2% by year-end.

The article summarizes consensus sentiment as: “The economy is too strong for the second-longest rally since 1950 to end now.”

The FOMC – with its infamous “dot plot” projecting interest rate hikes beyond 2017 – is implicitly forecasting the 2nd longest economic expansion in U.S. history.

It’s “obvious” that consensus remains bulled up on each of the aforementioned cycles and, while we are not calling for an immediate inflection in either, we do think “bet[ting] on the unexpected” requires distancing oneself from the herd of near-universal bullishness. In financial market terms specifically, we offered our latest asset allocation thoughts in the following video: http://app.hedgeye.com/m/ZG+/aQXNs6/consumerslowing-again.

I've been waiting, patiently, to start re-shorting some of these commodity plays and as our Industrials analyst Jay Van Sciver wrote recently "the only thing worse than forecasting a stock is forecasting a stock based on a commodity that is dependent on the weather."

Per Jay, excessive rain in parts of the U.S. Midwest, along with some drought conditions in Europe, pushed prices for Corn, Soy, and Wheat higher this past week. But my risk management signal wouldn't call that a bullish TREND (it was a counter-TREND trade).

Shorting DE high,

KM

Share

Print

07/01/15 12:58 PM EDT

GIS | Flat Performance Persists, But Moving in the Right Direction

General Mills is on the Hedgeye Best Ideas list, and after this quarter we remain confident in our position on GIS. Robust performance was seen in the core growth businesses, while management has a keen eye on improving struggling businesses.

Today, GIS reported Q4 FY15 and it was basically what we were expecting, not awe inspiring but not a disappointment either. Below is a look at the numbers for the quarter and the year:

FOURTH QUARTER SUMMARY:

Net sales: Reported net sales were $4,299mm missing consensus estimates of $4,547mm by ~5.5%. Versus the same period last year, top line was up 6% on a constant-currency basis. The 53rd week in this year contributed 6 points of net sales growth in the fourth quarter.

Adjusted diluted EPS: Beat consensus of $0.71 by $0.04 and increased 12% versus the same period last year to $0.75 on a constant-currency basis. The 53rd week contributed roughly the difference between consensus and actual adjusted diluted EPS.

FISCAL 2015 SUMMARY:

Net sales: Net sales increased 1% on a constant-currency basis to $17,630mm, coming in just shy of consensus at $17,635. The 53 week contributed roughly 1 point of net sales growth and the addition of the Annie’s business provided another 1 point lift. So backing those out sales were down roughly 1%. This year started off rough, but gained traction in the 2H, and we expect this momentum to continue into FY16.

Adjusted diluted EPS: Totaled $2.86 for the full year, up 4% from a year ago levels on a constant-currency basis. The 53rd week drove much of the improvement versus last year, contributing $0.04 of EPS for the full year.

LET’S TALK ABOUT THE COMPANY BY SEGMENT

U.S. Retail ― For the year the segment declined 1% to $10.5bn, reflecting lower pound volume. U.S. operating profit declined 7% to $2.2bn. Although the year in total was a disappointment, one must look at the quarter by quarter progression. In the 2H GIS showed signs of improvement. Q4 net sales increased 5% to $2.5bn; pound volume contributed 3 points, while net price realization and mix added another 2 points. Segment operating profit totaled $565mm, a 13% increase versus the same period last year.

In the 2H of the year Snacks grew at HSD to MDD rates, Yogurt up LDD to HSD, and Cereal returned to growth albeit against a week comp, sales were up 3%. They are still struggling in some areas such as baking products, where we have suggested a divestiture, but management seems adamant that their turnaround efforts will be effective.

Gaining Share in Key Categories: General Mills improved their share in key growth categories for the company. Increasing Grain Snacks share by 168 basis points (bps), Frozen Hot Snacks by 97bps, Yogurt by 88bps, RTE Cereal by 26 bps and Frozen Pizza by 23bps. Now, not all the performance was positive they lost substantial share in underperforming categories; Frozen vegetables lost 168bps, Dessert Mixes down 144bps and Dry Packaged Dinners down 72bps, all categories that we believe need to be divested.

Natural & Organic is at the forefront of every food discussion, and GIS is adapting. Their portfolio has grown to $700mm in sales, well on their way to $1bn by 2020. And they are innovating, Annie’s brand will be launching a soup this summer just in time for the core soup season (Fall/Winter), Food Should Taste Good has a bar now and Larabar is gaining distribution with sampling and media backing its growth.

Robust growth seen across the segment, on a constant-currency basis, Latin America increased 17%, Asia / Pacific up 5%, Europe up 5% and Canada was about flat. This robust growth was driven by innovation in key markets like Brazil with Yoki and China’s dumpling and ice cream businesses.

Yoplait in China is on shelf in Shanghai and the business is seeing a positive initial reaction. It remains unclear on when this business will provide meaningful earnings for the company.

C&F continues to improve the product portfolio by pruning lower performing SKUs, freeing the business to focus on the key priority platform. These platforms (cereal, snacks, yogurt, mixes, biscuits and frozen breakfast) are providing all the growth for the division, collectively up 9% this year.

FY16 Management Summary ―

Expanding our consumer-first focus to generate growth

Investing in core renovation and incremental innovation

Disciplined cost management

Continued emphasis on shareholder returns

FY16 Hedgeye Guidance ―

Looking into FY16 we are excited about the possibilities. Management is working hard on their “Consumer First” initiative and making great changes to current product while also introducing new products. Below is not a comprehensive list but some of the biggest things that we are looking forward to this year:

Yoplait in China

Gluten-Free Cheerios

No artificial colors or flavors in the cereal

Granola innovation / Muesli

Greek Plenti / Whips

Original Yoplait yogurt sugar reduction

Renovation on Grain Snacks

Strong push on Natural & Organic products

Delivering Value to consumer on brands like Totino’s and Hamburger Helper

Bringing U.S. innovation International

Bottom line is they are still struggling; we don’t want to shy away from that. But the core of the portfolio is growing and management seems to be working tirelessly on implementing changes to grow the rest of the portfolio, especially cereal. We also still believe that to have continued growth into the future a sizeable acquisition or divestiture would be beneficial to the business.

We will be attending the General Mills analyst day on July 14 in Boston. Coming out of that we will dive deeper into what we think GIS can do this year.

VIRT: Adding Virtu Financial to Investing Ideas (Bear Side)

I've been waiting for one of Jonathan Casteleyn's best new ideas (on the bear side) to bounce to the top-end of the range (on decelerating volume)... and here's what I've been waiting for.

Shorting VIRT is a good way to express what I'm really bullish on right now (have been since July of last year), and that's market volatility.

Per JC, "shares of newly issued Virtu Financial (VIRT) are very richly valued and despite principal risk in their daily trading operations, the stock is being priced in-line with the exchanges.

VIRT has no tangible equity capital to absorb a potential trading loss and would have to draw down credit lines should their historical track record in trading break down. We estimate shares are worth $18 per share or the mid point of our scenario analysis."

Short Green,

KM

Share

Print

Early Look

daily macro intelligence

Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.

Thank You!

Your request has been received

You have been added to our list and will receive an email shortly.

If you do not receive an email, please check your spam filter, and then email
support@hedgeye.com.
By joining our email marketing list you agree to receive emails from Hedgeye. This is a distinct and separate service form any of our paid service products. You may unsubscribe at any time by clicking the unsubscribe link in one of the emails.